The amount of money that you can borrow with an FHA mortgage is largely dependent on a simple math formula called debt to income. There are two parts to the calculation. The first calculation is the payment estimation. The second calculation is the monthly debt analysis.
FHA lenders want borrowers to have a maximum mortgage payment that is approximately 31% of the gross monthly income. For example, if the monthly income is $3,332, the ideal mortgage payment would be $1,032.92 (.31 X 3,332 = 1,032.92). Lenders call this calculation the "front-end ratio".
In addition to the payment ratio, FHA lenders also consider the amount of debt that is paid each month. Monthly bills include car, school, child support, alimony, and other obligations. Lenders have a ratio for debt. The debt ratio is called the "back-end" ratio. The debt ratio is the total amount of debt that is paid each month and the proposed mortgage payment with real estate taxes, homeowner's insurance, FHA mortgage insurance, and any other monthly payment, such as a homeowner's association fee.
The "ideal" debt ratio is 43%. In other words, the total amount of debt, including the new mortgage payment should not exceed 43% of the monthly gross income.
|Debt to income calculation|
|Proposed Mortgage payment||$800.00|
|credit card payment||$200.00|
|Total Monthly Debt||$1,445.00|
|Debt ratio||$1,445.00||divided by||$3,332.00||=||0.43|
But, like most things in life, there are exceptions. The FHA debt ratios can be exceeded provided there are "compensating factors".
FHA debt to income ratio exceptions
(B) Cash Reserves that have been independently confirmed and recorded.
If the following conditions are met, verified and recorded cash reserves may be mentioned as a compensation factor.
Reserves equal or exceed three total monthly mortgage payments (one and two units) or six total monthly mortgage payments (one and two units) (three and four units).
Reserves are calculated as the borrower's total assets, as indicated in Asset Requirements:
Gifts, borrowed money, and cash received at closing in a cash-out refinancing transaction or incidental cash received at closing in a mortgage contract.
(C) Housing Payments Increase by a Minimal Amount
A little increase in the housing payment may be used as a compensatory factor if the following conditions are met:
The new monthly mortgage payment does not surpass the existing monthly housing payment by more than $100 or 5%, whichever is smaller;
and a 12-month history of on-time housing payments with no more than one 30-day late payment
All payments on the refinanced mortgage must have been paid within the month due for the preceding 12-months in cash-out transactions.
Mortgagees may not use this compensatory factor if the Borrower is not currently making a mortgage payment.
The Borrower's current total monthly mortgage payment or current total monthly rent obligation is referred to as the Current Total Monthly Housing Payment.
(E) There is no revolving debt.
Unless the following conditions are met, no discretionary debt may be mentioned as a compensating factor:
The borrower's housing payment is the only open account with an outstanding balance that is not paid off monthly.
The credit report demonstrates that the borrower has created credit lines in his or her name that have been open for at least six months, and that the borrower can verify that these accounts have been paid off in whole each month for at least six months.
Borrowers who have no established credit other than their mortgage payment, no other credit lines in their own name open for at least six months, or who are unable to show that all other accounts have been paid off in full for at least the last six months do not qualify.
This criterion does not apply to credit lines for which the borrower is an authorized user but which are not in their name.
(E) Significant Additional Earnings Are Not Reflected in Effective Earnings
If the following requirements are met, additional revenue from overtime, bonuses, part-time, or seasonal employment that is not represented in Effective Income may be used as a compensatory element:
The Mortgagee must verify and document that the borrower has been receiving this income for at least one year and that it is expected to continue, as well as that the income, if included in gross effective income, is adequate to reduce the qualifying ratios to no more than 37/47.
This criteria may exclude income from non-borrowing spouses or other non-obligated parties.
This compensating factor may only be mentioned in conjunction with another compensating factor when qualifying ratios exceed 37/47 but do not exceed 40/50.
SOURCE: 4000.1 Handbook
Page 326 was last updated on December 30, 2016.
SOURCE:Handbook 4000.1 Last Revised: 12/30/2016 page 326
Frequently Asked Questions About Debt To Income
Q. Does alimony and child support count?
A. Alimony and child support must be included in the FHA debt to income ratio provided the payments are court-ordered or otherwise agreed upon. The borrower must provide the lender with the official signed divorce decree, separation agreement, maintenance agreement, or other legal order.
Q. I am a co-signer on a credit card account, does that count?
A. If the Borrower is an authorized user/co-signer on an account, the monthly payment must be included in a Borrower's debt to income ratio unless the borrower can document that the primary account holder has made all required payments on the account for the previous 12 months. Canceled checks or bank statements are usually sufficient documentation to exclude the liability.
The payment amount must be included in the Borrower's debt to income ratio computation if less than three payments have been made on the account in the previous 12 months.
Q. FHA debt to income calculation in community property states
A. There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska is an opt-in community property state that gives both parties the option to make their property community property.
According to the FHA guidelines:
If the Borrower resides in a community property state or the Property being insured is located in a community property state, debts of the non-borrowing spouse must be included in the Borrower’s qualifying ratios, except for debts specifically excluded by state law.
The non-borrowing spouse’s credit history is not considered a reason to deny amortgage application. SOURCE:Handbook 4000.1 page 264
Collection accounts - Unless specifically excluded by state law, the $2,000 cumulative amount of a non-borrowing spouse in a community property state must be included in the $2,000 cumulative total and considered as part of the Borrower's ability to pay all collection accounts. Page 195
Judgments - In a community property state, non-borrowing spouse's judgments must be addressed or paid in full, with the exception of liabilities excluded by state law. Page 257
Q. I have student loans that are deferred
A. The lender is required to include all monthly obligations that are disclosed on the credit report. If the student loan is in a deferred status and the likely monthly payment is not listed on the credit report, the lender is required to use 1% of the deferred loan as the monthly payment for debt to income purposes. For example, a $50,000 deferred loan is equal to a $500 monthly payment for FHA qualification.
Q. What bills are included in the debt to income ratio?
A. All applicable monthly liabilities must be included in the qualifying debt ratio. Closed-end debts, such as car loans, do not have to be included in the calculation if the loan will be paid off within 10 months and the cumulative payments of all such debts are less than or equal to 5 percent of the Borrower's gross monthly income. The Borrower may not pay down the balance in order to meet the 10-month requirement.